Bad News Is Good News

Good news.  The economy still stinks.

In today’s economy, which is driven by The Federal Reserve Board’s quantitative easing (QE) program, bad news is good news and good news is bad news.  That’s because if the economic news is bad, The Fed will be more likely to continue buying bonds, propping up the stock market.

A month ago, the U.S. Bureau of Economic Analysis (BEA) estimated an annualized growth rate of 2.4% for the first quarter of 2013, but on Wednesday the BEA revised its estimate and said the economy grew at a rate of only 1.8%, a full 25% drop.

Growth of 1.8% is 45% lower than the 3.3% average annual growth in gross domestic product (GDP) the U.S. economy has enjoyed post-World War II.  Yet the Dow Jones Industrial Average and the S&P 500 each jumped a full percentage point on the news.  The DJIA was up 149.83 points and the S&P 500 was up 15.23 points.

Why QE?

The goal of QE, we were told, was to cut unemployment to 6.5%.  After more than five years and three rounds of QE (plus Operation Twist), the une

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Market Reaction To Comments Reflects Market Efficiency

It’s worth keeping the efficient market hypothesis in mind when considering the impact of Fed Chairman Ben Bernanke’s announcement this week that bond buying will be coming to an end.

The efficient market hypothesis suggests that share prices always incorporate and reflect all relevant information. While the hypothesis may be flawed, it should be no surprise that markets react to information, and that the announcement itself would have an impact, even though no one knows for certain when quantitative easing (QE) will end or when “tapering” or bond purchases will begin.

The price of a security at any given time reflects not only the performance of a company in the context of overall market conditions, but future expectations. So markets panicked because the Fed chief acknowledged the obvious – that QE will be ending someday.

Other than admitting the obvious, The Fed’s comments were inconclusive, with plenty of “ifs,” “ands” and “buts,” and the market performance has been similarly inconclusive, jumping up and down enough to make investors seasick.

That queasy feeling is caused by volatility, which we discussed last week.

Can 54 Economists All Be Wrong?

Based on Fed comments, Bloomberg interviewed 54 economists for their opinions about what’s happening when.  The consensus is that monthly bond purchases will drop from $85 billion to $65 billion in September and QE will end completely in June 2014.  Nearly half of the economists – 44% — predicted that tapering would begin in September, compared with 27% in a survey taken at the beginning of June.

Of course, prognosticators are frequently wrong.  The economy continues to be as volatile as the market has become and the political climate may also be a factor, especially as Mr. Bernanke’s term comes to an end.  There also appears to be growing disagreement among board members about when to end QE and when to taper off bond buying.

Stock vs. Flow

One aspect of the QE tapering debate that has attracted some attention is Read more

Swinging Markets Ahead

Volatility is back in a big way.  It’s back not only in the stock market, but in the bond market.  It’s back not only in the U.S., but in China, Japan and other countries.  It’s back not only in developed countries, but in emerging markets.

Just a few signs that volatility has returned:

  • The Dow Jones Industrial Average (DJIA) has had intraday swings of more than 100 points in 10 straight sessions.  On five of those days, the market finished up; on five, it finished down.
  • The Chicago Board Options Exchange Volatility Index (VIX) has jumped more than 40% since May 17.
  • Trading in VIX futures set records for each of the first four months of the year.  May was the third most active trading month ever.
  • The yield on 10-year U.S. Treasuries hit a 14-month high of 2.27% during Tuesday’s trading.

The VIX, also known as the “fear gauge,” jumped from a low of 12.26 on May 17 to 17.25 on Tuesday, but it is still at a relatively low level.  In 2011, it was regularly over 30 and in 2008, it rose over 80.

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Take Advantage of Rising Interest Rates by Understanding Duration

Recently, there has been a lot of news about rising interest rates ending the bond rally.

Investors who have a significant percentage of their investments in bonds may be getting nervous, but there’s a simple strategy for protecting principal and taking advantage of increasing interest rates.

Bonds generally make up a significant portion of a diversified portfolio, so if the bond rally is over, it is important to be positioned in bonds that will maintain their value in a rising interest rate environment.

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